Venture Capital Funds are regulated by the Securities and Exchange Commission (SEC) via a series of federal securities laws. Depending on the structure you may need to also look at Cayman law or EU directives as they apply to Venture Capital Funds.
In the US a Venture Capital Fund is a pooled investment vehicle generally formed as a Limited Partnership. A Limited Partnership generally has two entities, 1) the General Partner who holds control and makes all investment decisions, and 2) the Limited Partners who are the investors and cede power to make investment choices to the General Partner.
You may also have a Master Feeder Structure to accommodate investors from non-US jurisdictions. In this case, you would have the pooled investment vehicle mentioned above as well additional structures formed in a off-shore or EU jurisdiction. In this case you would generally form a Company that would allocate shares to the investors, however there would be a separate category for management shares issued to the General Partner or Management Company. Then you would form the Master Fund, which would accept the assets of the Domestic US Limited Partnership and the assets of the off-shore or EU Company. The Master Fund makes the investment decisions, then allocates the profits or losses back to each of the sub funds.
For further descriptions see:
Venture Capital Funds are subject to ongoing compliance obligations in order to maintain their exemption. These obligations include fiduciary duties, pay-to-play restrictions, and recordkeeping requirements.
Fiduciary Duties
Exempt venture capital funds, have a legal obligation to act in their clients’ best interests and avoid conflicts of interest. They are required to fulfill a duty of care and a duty of loyalty, which involve providing advice that is in the client’s best interest, exercising due diligence in investment decisions, and avoiding conflicts of interest.
Pay-to-Play Restrictions
Pay-to-play restrictions are rules that prohibit investment advisers, including exempt venture capital funds, from providing advisory services for compensation to government entities after making political contributions to an official of that entity. These restrictions are intended to:
• Prevent conflicts of interest
• Ensure fair and transparent investment practices
• Prevent investment advisers from using political contributions to influence government officials and secure investment opportunities.
To prevent pay-to-play violations, exempt venture capital funds should establish robust compliance policies, prohibit employees from making certain political contributions, and remain knowledgeable about the pay-to-play rule.
Recordkeeping Requirements
Under Section 204 of the Advisers Act, exempt venture capital funds are required to maintain accurate records and circulate relevant reports as determined by the SEC. These records include investment advice provided to clients, as well as records demonstrating compliance with the exemption requirements.
Maintaining accurate and complete records helps exempt venture capital advisers prepare for potential regulatory examinations and maintain their exemption status.
For more information see: SEC.gov | General Information on the Regulation of Investment Advisers
The Investment Advisers Act of 1940 is a federal law that governs investment advisers, including investment adviser professionals, and their registration requirements. Passed with the intent to regulate individuals and firms providing investment advice to clients, its primary objective is to ensure investment advisers act in the best interests of their clients and avoid conflicts of interest by registering with the Securities and Exchange Commission (SEC) under the Investment Company Act.
Regulation D outlines rules funds or companies can follow to sell their securities without registering the offering with the SEC. Most private capital is raised under the framework outlined in Rule 506 of Regulation D, either through Rule 506(b) or Rule 506(c).
Rule 506 of Regulation D is a safe harbor. If a fund complies with the rule, the SEC considers it to be making a private placement and not a public offering, which means the fund can avoid the costs associated with SEC registration and related reporting requirements.
Venture capital funds are able to raise an unlimited amount of capital from accredited investors under both provisions of Rule 506, though the fund will still have to abide by the investor limits in 3(c)(1) and 3(c)(7).
Under Rule 506(b), funds aren’t allowed to publicly market or solicit their fundraising efforts outside of previously established personal and professional networks. But investors in 506(b) funds can self-certify as accredited investors.
Under Rule 506(c), fund managers are able to publicly advertise their funds, but they must take reasonable steps to verify that investors are accredited.
Rule 506(b) is still the predominant framework used to raise private capital because it can be burdensome and costly to verify that investors are accredited.
Funds raising capital under Regulation D have to file Form D, which asks for information about the entity raising money and the size of the sale. The fund must submit Form D to the SEC within 15 days of the first sale or risk being locked out of future Regulation D offerings.
In addition to federal regulations, exempt venture capital advisers must also comply with state-specific registration and exemption requirements. The process for complying with these requirements can vary by state. To apply for state-specific exemptions, advisers should review the specific regulations of each state and follow the registration process outlined by the state’s securities regulator.
To qualify for the venture capital exemption, investment advisers must meet certain criteria that demonstrate their focus on venture capital funds. These criteria include pursuing a venture capital strategy, adhering to investment holding limitations, and maintaining limits on leverage.
Private Fund Exemptions from registration under the Investment Company Act Exemption:
3(c)(1) - Any fund not publicly offered with fewer than 100 beneficial owners who are all accredited investors
Qualifying venture capital funds managing less than $10M with fewer than 250 beneficial owners
3(c)(7) - Any fund not publicly offered whose investors are qualified purchasers.
The fund is limited to 1,999 investors to avoid SEC registration under the Securities Exchange Act of 1934
Exempt Reporting Advisers (ERAs)
If you qualify as an exempt reporting adviser (ERA), you may be able to avoid some of the regulatory requirements associated with being a registered fund adviser.
You can qualify as an exempt reporting adviser if you meet one of the following exemptions:
• Private fund adviser exemption: You solely advise private funds totaling less than $150 million in assets under management
• Venture capital adviser exemption: You solely advise venture capital funds (with no asset limit)
Qualifying for either the private fund adviser exemption or the venture capital adviser exemption doesn’t mean you’re exempt from regulation. Exempt reporting advisers are still subject to certain reporting requirements, including completing certain portions of Form ADV, which contains information about the fund manager and its business operations. Information reported on Form ADV is publicly available.
15 U.S. Code § 80b–3 - Registration of investment advisers
(l)EXEMPTION OF VENTURE CAPITAL FUND ADVISERS
(1)IN GENERAL
No investment adviser that acts as an investment adviser solely to 1 or more venture capital funds shall be subject to the registration requirements of this subchapter with respect to the provision of investment advice relating to a venture capital fund. Not later than 1 year after July 21, 2010, the Commission shall issue final rules to define the term “venture capital fund” for purposes of this subsection. The Commission shall require such advisers to maintain such records and provide to the Commission such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.
(2)ADVISERS OF SBICS
For purposes of this subsection, a venture capital fund includes an entity described in subparagraph (A), (B), or (C) of subsection (b)(7) (other than an entity that has elected to be regulated or is regulated as a business development company pursuant to section 80a–53 of this title).
(3)ADVISERS OF RBICS
For purposes of this subsection, a venture capital fund includes an entity described in subparagraph (A) or (B) of subsection (b)(8) (other than an entity that has elected to be regulated as a business development company pursuant to section 80a–53 of this title).
For more information see:
The SEC defines a VC Fund under
§ 275.203(l)-1 Venture capital fund defined.
(a) Venture capital fund defined. For purposes of section 203(l) of the Act (15 U.S.C. 80b–3(l)), a venture capital fund is any entity described in subparagraph (A), (B), or (C) of section 203(b)(7) of the Act (15 U.S.C. 80b–3(b)(7)) (other than an entity that has elected to be regulated or is regulated as a business development company pursuant to section 54 of the Investment Company Act of 1940 (15 U.S.C. 80a–53)) or any entity described in subparagraph (A) or (B) of section 203(b)(8) of the Act (15 U.S.C. 80b–3(b)(8)) (other than an entity that has elected to be regulated or is regulated as a business development company pursuant to section 54 of the Investment Company Act of 1940 (15 U.S.C. 80a–53)) or any private fund that:
(1) Represents to investors and potential investors that it pursues a venture capital strategy;
(2) Immediately after the acquisition of any asset, other than qualifying investments or short-term holdings, holds no more than 20 percent of the amount of the fund's aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied by the fund;
(3) Does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage, in excess of 15 percent of the private fund's aggregate capital contributions and uncalled committed capital, and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 calendar days, except that any guarantee by the private fund of a qualifying portfolio company's obligations up to the amount of the value of the private fund's investment in the qualifying portfolio company is not subject to the 120 calendar day limit;
(4) Only issues securities the terms of which do not provide a holder with any right, except in extraordinary circumstances, to withdraw, redeem or require the repurchase of such securities but may entitle holders to receive distributions made to all holders pro rata; and
(5) Is not registered under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a–8), and has not elected to be treated as a business development company pursuant to section 54 of that Act (15 U.S.C. 80a–53).
(b) Certain pre-existing venture capital funds. For purposes of section 203(l) of the Act (15 U.S.C. 80b–3(l)) and in addition to any venture capital fund as set forth in paragraph (a) of this section, a venture capital fund also includes any private fund that:
(1) Has represented to investors and potential investors at the time of the offering of the private fund's securities that it pursues a venture capital strategy;
(2) Prior to December 31, 2010, has sold securities to one or more investors that are not related persons, as defined in § 275.206(4)–2(d)(7), of any investment adviser of the private fund; and
(3) Does not sell any securities to (including accepting any committed capital from) any person after July 21, 2011.
(c) Definitions. For purposes of this section:
(1) Committed capital means any commitment pursuant to which a person is obligated to:
(i) Acquire an interest in the private fund; or
(ii) Make capital contributions to the private fund.
(2) Equity security has the same meaning as in section 3(a)(11) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(11)) and § 240.3a11–1 of this chapter.
(3) Qualifying investment means:
(i) An equity security issued by a qualifying portfolio company that has been acquired directly by the private fund from the qualifying portfolio company;
(ii) Any equity security issued by a qualifying portfolio company in exchange for an equity security issued by the qualifying portfolio company described in paragraph (c)(3)(i) of this section; or
(iii) Any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary, as defined in section 2(a)(24) of the Investment Company Act of 1940 (15 U.S.C. 80a–2(a)(24)), or a predecessor, and is acquired by the private fund in exchange for an equity security described in paragraph (c)(3)(i) or (c)(3)(ii) of this section.
(4) Qualifying portfolio company means any company that:
(i) At the time of any investment by the private fund, is not reporting or foreign traded and does not control, is not controlled by or under common control with another company, directly or indirectly, that is reporting or foreign traded;
(ii) Does not borrow or issue debt obligations in connection with the private fund's investment in such company and distribute to the private fund the proceeds of such borrowing or issuance in exchange for the private fund's investment; and
(iii) Is not an investment company, a private fund, an issuer that would be an investment company but for the exemption provided by § 270.3a–7 of this chapter, or a commodity pool.
(5) Reporting or foreign traded means, with respect to a company, being subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), or having a security listed or traded on any exchange or organized market operating in a foreign jurisdiction.
(6) Short-term holdings means cash and cash equivalents, as defined in § 270.2a51–1(b)(7)(i) of this chapter, U.S. Treasuries with a remaining maturity of 60 days or less, and shares of an open-end management investment company registered under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a–8) that is regulated as a money market fund under § 270.2a–7 of this chapter.
NOTE:
For purposes of this section, an investment adviser may treat as a private fund any issuer formed under the laws of a jurisdiction other than the United States that has not offered or sold its securities in the United States or to U.S. persons in a manner inconsistent with being a private fund, provided that the adviser treats the issuer as a private fund under the Act (15 U.S.C. 80b) and the rules thereunder for all purposes.
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